Sendhil Mullainathan is a brave economist. I say that because the Harvard professor and recipient of a MacArthur “genius” grant admitted in a recent New York Times piece that until recently he had no recollection how he had invested his retirement funds, and that when he finally got around to checking he discovered to his chagrin that a substantial proportion was in cash—a big no-no for anyone saving money for the long run.
He’s not alone: I know numerous economists who have made similarly boneheaded investment errors. One friend quit his job precisely one week before his employer’s matching contributions vested. Another worked at his job for five years without realizing there was a generous employer match—and had never bothered to put a dime into his retirement account. Still another put his retirement investments into low-interest government bonds his first decade on the job.
The “economists as investment naïfs” club includes me in its rolls as well. I didn’t enroll in a retirement account the first year at my first job: It wasn’t until I chatted with a financial adviser that I was forced to confront my own stupidity. He also gave me some sage advice, gently suggesting I diversify my retirement portfolio in foreign stock funds, a strategy that has served me well.
Such nudges may soon become rarer, as the Department of Labor has proposed new regulations that would overhaul the relationship between the investor and financial advisers. The regulations would make it all but impossible for investment advisers to put clients into funds from which they receive a commission. It would thereby drastically change how investors could compensate financial advisers and would likely increase the cost of most financial advice for middle-class investors, which ought to result in fewer middle-class savers receiving advice.
The implicit assumption in this regulation—one that an accompanying study by the Council of Economic Advisers made all but explicit—is that most people should put their assets in a passively managed index fund, which would not require the services of a financial adviser.
While simply investing in an index fund may make sense for the bulk of households under age 50, many people don’t manage to do that even in a world where automatic enrollment is the norm. Wanting to automate investment decisions may help households merely constrained by inertia, but many other people need more than a nudge: They want someone who thinks about these issues for a living to help them make decisions that can be stressful and complicated.
The White House and various supporters of the regulation have extolled the federal government’s Thrift Savings Plan, implicitly suggesting that this might serve as a model for investors. The program offers a handful of different funds—besides its index fund it has a bond fund, a small stock fund, and an international stock fund, along with some lifecycle funds. Each of these is passively managed with very low fees: The fee for the stock index fund is less than three basis points per fund, or three cents per $100—that’s less than 20 percent of Vanguard’s famously low expense ratio.
Having access to funds with minuscule expense ratios, federal workers must be quite happy with the Thrift Savings Plan (TSP), right? You might think so, but there has been a growing dissatisfaction with the—wait for it—lack of investment advice in the system. John Turner, an economist at the Pension Policy Center, reports that nearly half of all federal employees withdraw their money from TSP within a year after leaving their government job.
While the administration suggests that these people are being lured into making a grievous mistake by smooth-talking advisers, most people seem to want a modicum of advice and are willing to pay for it, if necessary, by putting their money into funds with higher management fees. In a recent survey of TSP participants, 48 percent of respondents said their biggest complaint with the retirement plan was the lack of advice. In response, TSP administrators are endeavoring to shift gears in order to allow TSP to provide more advice for its participants—something that would eventually boost management fees.
Federal government employees are generally well-educated, middle-class, well-informed folk: If they are forgoing the low, low investment costs associated with TSP for products that come with advisers, putting up barriers for other people wanting the same sort of advice is nonsensical.
Perhaps no one typifies the complicated nature of retirement investment better than a former high-level federal employee recently profiled by Bloomberg Business. She entered government service in the 1990s. Upon leaving her previous job to enter government service she cashed out her defined-benefit pension, and did the same thing with her TSP upon leaving her government job. While working for the government she tapped another 401(k) account even though she wasn’t close to retirement age. Her saving grace, she confesses, was the advice she received from her son—a banker at Goldman Sachs—who helped persuade her to stop putting her remaining retirement funds in cash and to be less cavalier in her decision-making. “Investing is too hard,” she says simply.
This confused investor happens to be Alicia Munnell, who was no ordinary government employee: She has a Ph.D. in economics from Harvard and was a member of President Clinton’s Council of Economic Advisers, later serving as assistant secretary for policy in the Treasury. For the last 17 years she has run the Retirement Research Center at Boston College. If there’s anyone who ought to be capable of making investment decisions on her own, it is she. And those of us without investment banker offspring—what are we supposed to do?
It looks like we’re about to find out, unless the Obama administration changes its mind.
Life isn’t getting any simpler. Automating investment decisions to a greater degree is a good way to help inertia-ridden investors, but making it more difficult and costly for others to purchase investment advice threatens to make millions of Americans feel less secure about their retirement and potentially result in lower savings.
Ike Brannon is the head of the Savings and Retirement Foundation.
